LOS ANGELES - Some investors reacted nervously Friday to the news that Orange County, Calif., defaulted on $110 million of variable-rate taxable pension obligation bonds.

They fear that if a default happened once, it will happen again, market observers said.

County spokeswoman Sandra Sternberg said "we don't believe there is a problem" with other bond defaults looming, but she added, "We haven't looked into it."

"There is a lot of panic relating to a lot of other bond issues," said Sandra H. Leess, a senior vice president with U.S. Trust Co. of California, the trustee for the ill-fated pension bond deal.

Investors in conduit-type issues for local governments in Orange County whose debt service payments are secured by a letter of credit are worried, even though the issues are "not in troble," Leess said.

The bank that supports that LOC is still in fine shape, yet people are panicking and tendering bonds left and right" she said.

David Herships, a first vice president for Kemper Securities Inc., said there is "a very good possibility" of other defaults in the county, but it is "unclear who is next."

Said Herships, "Everyone who is in Orange County is at risk to varying degrees, depending on a whole host of factors, including whether their debt service reserve funds are outside the loop of the county investment pool."

Issued in late September, the defaulted pension bond issue was one of two series of taxable pension bonds sold in a negotiated deal with CS First Boston Corp. as the senior managing underwriter.

A spokesman for CS First Boston said he was unable to provide information on the transaction late Friday. Jerry Gold, director of O'Brien Partners Inc., the deal's financial adviser, had no comment.

The defaulted Series 1994B used floating-rate instruments backed by the liquidity of the county's investment pool.

The other series, Series 1994A, totaling $210 million, used a fixed-rate structure that is not in immediate jeopardy of default because bondholder payments are not due until next March 1, Leess said.

The county deposited a full year's worth of debt service with U.S. Trust on both the fixed- and variable-rate portions, and as a result, the trustee "will be paying their [bondholders'] interest payments, at least for the time being," Leess said.

She added that variable-rate interest payments will be made monthly, and an interest-only payment on the fixed-rate portion is due March 1.

"We have been in communication with the bondholders, and we are formulating a strategy as far as how to deal with the default" Leess said. `Certainly, we'll need to file a proof of claim in the bankruptcy court. There are a number of different laws that are applicable. What we and our counsel are going to be doing is evaluating the different applicable laws to see where we have remedies."

Leess said a municipal bankruptcy "does create some problems in terms of coping with the default that we're going to have to plow through before any resolution."

The technical default came to light late Thursday when Moody's Investors Service issued a release that said it had been notified by the county that "it has defaulted on these bonds due to the Orange County Investment Pool's inability to allow the county access to its unrestricted funds in an amount sufficient to redeem tendered bonds."

Moody's, which earlier had suspended its rating on the bonds, reinstated the rating and then lowered it to Caa. When originally issued, the bonds had been rated A1/VNHGI. Standard & Poor's Corp. also originally rated the Series 1994B bonds, AA-minus/A1-plus. Standard & Poor's has placed the county's debt on CreditWatch.

A source who asked not to be identified said the chain of events that led to the default began Dec. 1, when the first signs of Orange County's impending financial failure began unfolding.

"There was a tender for some of the bonds" the source said. "It is a seven-day demand note."

U.S. Trust Co. then notified the remarketing agent - CS First Boston - that investors were demanding their money back with only seven days notice, the source said.

"First Boston is responsible for remarketing," source said. "If they cannot remarket the notes, they are responsible for then notifying the trustee that the obligations have not been remarketed."

At that point, U.S. Trust notified the county - the liquidity provider - "that liquidity is needed"' the source said. "The liquidity provider makes the money available."

"The treasurer, as custodian of the county's funds, then notified county supervisors that they cannot give them the money because of the bankruptcy," and the technical default occurred, the source added.

The pension bonds deal was one of the last financings, the county brought to market before the investment pool catastrophe came to light.

The deal was believed to be the first pension obligation bond issue to use a variable-rate structure. In mid-October, a $1.97 billion pension bond deal that also had a variable-rate component was sold by Los Angeles County.

At the time of pricing, then-Orange County assistant treasurer and now acting Treasurer Matt Raabe characterized the variable-rate fraction as innovative, and told The Bond Buyer it reflected California's penchant "to try new ideas before the rest of the country."

"Orange County is a good highquality credit," Raabe said during the interview. "People are waiting for this deal."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.